An article in yesterday’s Corporate Counsel highlights three instances in which indemnity provisions in contracts may fail to protect a party in the way a party intends and offers lessons on how a party might draft the contract to explicitly address these concerns.

Does the Indemnity Cover Counterparty Claims, Third-Party Claims, Or Both? A contract might contain an indemnity provision, stating that a party will pay for the other’s losses related to: (a) certain third-party claims; (b) certain breaches of contract or other counterparty claims; or (c) both. However, if an indemnity provision does not clearly specify to whom it applies, the parties might be left arguing about the indemnity’s application. An indemnity provision that is silent as to its application runs the risk of being found to apply only to third-party claims or only to counterparty claims. Therefore, a party should seek to draft the indemnity provision to expressly provide the circumstances to which the indemnity applies.

Is the Indemnity Subject To A Limitation-Of-Liability Provision? An indemnity provision might be restricted – intentionally or unintentionally – by provisions elsewhere in the contract, such as limitations of liability in the form of caps and baskets. Liability caps commonly provide an upper bound on the total liability to which a party is exposed under or related to a contract. Baskets commonly provide a materiality threshold, requiring damages to exceed that threshold before a party is liable to the other. A contract that is silent regarding whether a limitation of liability applies to an indemnity provision runs the risk of an unbounded indemnity or an indemnity subject to the limitation of liability. Therefore, a party should seek to draft a limitation of liability and an indemnity to explain their interaction, especially as to whether or not the limitation of liability applies to limit the indemnity provisions under the contract.

How Do Exclusions Of Certain Types Of Damages Interact With The Indemnity? In addition to the caps and baskets discussed above, contracts commonly contain provisions that limit the type of damages (e.g., consequential) recoverable by a party to the contract. Issues arise regarding the interaction of these types of liability limitations with the indemnity. For example, the Fifth Circuit found that a contract’s exclusion of consequential damages “of any kind or nature” did not limit the scope of the contract’s indemnity provision where the contract was silent as to the interaction of the two provisions. Therefore, a party should seek to make the contract expressly clear as to whether (and if so, how) the exclusion applies to any indemnity provisions under the contract.